If mortgage rates were pushed back to more normal levels (e.g., 7 to 8 percent), it would almost certainly lead to a sharp reduction in housing prices. Deliberately destroying trillions of dollars of wealth may seem like perverse policy, but it is important to recognize the context. If there is in fact an unsustainable run-up in housing prices, then the question is not whether prices will fall, but rather when prices will fall. The wealth is not really there. It is an illusion.

Housing economists can have a field day debating the wisdom of this proposition as a policy matter—I defer to their opinions. What piques me is the notion of “illusory wealth.” The housing bubble story reveals something fundamental about “wealth creation” via certain assets that mainstream economic measurement tends to ignore. For the 68% or so of people who own a house, rising real estate prices bring security and well-being. But for the rest, they can cause real anxieties. In many commodities markets, rising prices can induce more suppliers to meet the demand. But in many urban centers, there is little space left next to public transit or desirable amenities. Supply can’t rise to meet demand. So what we really have is a bidding war for prime space. Does this have any implications for law?

I think so, for a few reasons. First, these bidding wars focus our attention on how “growth” or “expansion” in one area of the economy may not reflect its efficiency or value, but merely its proprietors’ power to grab a bigger “slice of the pie.” Does a CEO’s salary really reflect his contribution to the well-being of the firm? Or merely his power over the compensation committee?

Housing prices often appear to reflect little about the actual utility of the underlying asset; rather, they’re driven by interest rates, financing options (anybody hear about the zero-down ARM? 40-year mortgage?), fashion, and panics (both to buy and to sell). Laws designed to stop risky financing are not mere paternalism; rather, they properly undermine an “arms race” that auction theory predicts will occur without outside intervention.

Anup Malani pushes insights like these in a way that deeply challenges conventional economic accounts of prices. According to Malani, “The value of a law should be judged by the extent to which it raises housing prices and lowers wages.” That may sound implausible, until one thinks of the extremes to which people are willing to go to live in a place like Tokyo or London. Once again, housing’s price is based less on the value of the underlying asset than on all manner of intangibles affecting perception of the value of the asset.

Second, the bubble discloses some of the distortive effects caused by inequality. For example, to have true deterrent effect, a fine should consume some percentage of income. But the U.S. tends to fine in fixed dollar amounts. A speeding ticket of $300 sends a much different signal to someone in the top 1% of wage-earners than it does to someone in the bottom half. A rising group of the “ultra-rich” will find it much easier to speculate in real estate than those who are merely rich. Both the wealthy speeder and real estate dabbler are engaged in potentially destructive behavior at above-optimal rates because the deterrents to such behavior (such as fines or housing market “crashes”) affect them far less than they affect the “average Joe.” To the extent we raise fines to stop the wealthy speeder, we may well be over-deterring poor Joe. I call this effect a “buying power externality” arising out of inequality, generating harms as real (and unreflected in market prices) as pollution or nuisance.

Finally, the bubble highlights problems of relative deprivation. As housing prices in certain areas rise to extraordinary levels, they become more than a way of determining the worth of an asset. Rather, they encourage a form of economic apartheid. An address becomes a badge of honor (or dishonor). When I worked at a big Washington firm, some colleagues would occasionally ask in disbelief “you live on the Green Line?!” I doubt they’d have made it to my dinner parties (if I’d had time to throw any!)

If this is all true, it adds one more reason why Robert Frank and Cass Sunstein should be declared the winners of their debate with Besharov and Viscusi. But that’s another post…and perhaps another article….

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Frank Pasquale

Frank is Professor of Law at the University of Maryland. His research agenda focuses on challenges posed to information law by rapidly changing technology, particularly in the health care, internet, and finance industries.

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